This article is an on-site version of our Unhedged newsletter. Sign up here to get the newsletter sent straight to your inbox every weekday
Welcome back. It’s the last day of August, which means that wonderful, all-purpose explanation for anything that happens in financial markets — “it’s August, everyone is on vacation, there’s no liquidity” — is set to expire. Make sure to get some use out of it while you can. Email me: [email protected]
Is an excess of rich people, not of middle-aged people, what depresses interest rates?
My expectation that nothing of interest would happen at the Federal Reserve’s Jackson Hole conference turned out to be wrong. Fed chair Jay Powell’s speech was boring, sure, but three academics redeemed the proceedings by presenting a paper investors would do well to read.
They argue that the primary force driving down interest rates is not demographic change, but income inequality. This is important for investors, because the demographic trend that has (in theory) put pressure on rates is set to reverse, while the trend towards greater income inequality looks like it’s locked in place.
Atif Mian, Ludwig Straub and Amir Sufi agree with partisans of the demographic view, such as the economists Charles Goodhart and Manoj Pradhan (whose view I have spent fair amount of space on here), that a key contributor to falling rates is higher savings. Savings chase returns, so when there are more savings and the same number of places to put them, rates of return must fall.
Mian, Straub and Sufi disagree, however, about why there are ever more savings sloshing around. It is not because the huge baby-boom generation is getting older and saving more (a trend that will change direction soon, when they are all retired). Rather, it’s because a larger and larger slice of national income is going to the top decile of earners. Because a person can only consume so much, the wealthy few tend to save much of this income rather than spend it. This pushes rates down directly, when those savings are invested, driving asset prices up and yields down; and indirectly, by sapping aggregate demand.
Why doesn’t all the cash that the rich push into markets get converted, ultimately, into productive investment, either at home or abroad? Tricky question. For present purposes it is enough to note that this is not happening — the savings of the American rich reappear, instead, as debt, owed by the government or by lower-income US households. (In another paper, MS&S have pointed out that this means the high share of income going to the rich hurts aggregate demand in two ways: the rich have a lower marginal propensity to consume, and governments and the non-rich are forced to shift dollars from consumption to debt service. Economically speaking, high inequality is a real buzzkill.)
MS&S prefer the inequality explanation for two reasons. Using data from the Fed’s Survey of Consumer Finances (which goes back to 1950) they show that differences in savings rates are much greater within any given age cohort than across age cohorts. That is, savings are building up faster because the rich are getting richer, not because the baby boomers are getting older. See these charts:
The Y axis in both charts shows savings as a proportion of income. The left-hand chart shows that the top 10 per cent of households save way more than anyone else, and well more (proportionally) than all people aged 45-54, the highest-saving age cohort, as seen on the right.
Another way to visualise the same point. Here is a heat map that matches savings rates (shown as colour) to income decile (Y-axis) on the one hand and age cohort (X-axis) on the other:
As you go left-to-right on that chart, moving across age cohorts, there is not a huge amount of change in colour. The dark red tones (that is, the high savings rates) are all crammed up at the top, with the richest people in each cohort.
This effect is dramatic, and is a really big change. In the past 20 years, the top decile has taken an extra third of national savings for itself, as compared to the pre-1980 period:
We estimate that between 3 and 3.5 percentage points more of national income were saved by the top 10 per cent from 1995 to 2019 compared to the period prior to the 1980s. This represents 30-40 per cent of total private saving in the US economy from 1995 to 2019.
The second reason for thinking that the rise in inequality is a better explanation for the rise in savings is that inequality has risen steadily over the period than rates have fallen — that is, since about 1980. The share of national income earned by the high-saving middle-aged, by contrast, has gone up and down as the baby boomers have aged and then started to retire. That is to say, inequality has a much tighter correlation to rates than demographics. In fact, MS&S argue that the SCF data show there is no correlation at all between overall savings rates and the share of income earned by the middle-aged.
What would Goodhart and Pradhan say in response? I don’t presume to answer for them, but two things strike me. One is that MS&S focus just on US data, and G&P are emphatic that, because capital and productive capacity moves across borders, you have to look at the global picture. Japan, for example, has not experienced falling rates or rising inflation as it has aged. It was able to keep prices down by moving productive capacity to China. Second, G&P think savings is only part of the picture; the supply of workers is important too.
I leave it to better economists to resolve the fight between the partisans of demographics and inequality, but I will say I find the MS&S view compelling. But who is more right is undoubtedly going to be important to investors, because the two sides disagree on the most likely path of rates from here on out.
A further note. I think if MS&S are right, the political implications are particularly nasty. Inequality, in their view, is self-perpetuating, with the feedback loop running through low rates. Excess savings of the rich depress rates; low rates push asset prices up; the rich get richer still. Many governments are engaging in monetary policies that, in all likelihood, make this flywheel turn faster. For how long are the people who sit outside this wealth machine — a majority of voters — going to tolerate this? This strikes me as even nastier than the intergenerational conflict you would expect if G&P are right (with the old fighting to keep the social safety net in place as working age people fight against ever-higher taxes).
Those of us who own a few assets, and have done so well as a result in recent decades, should give this some thought.
One good read
Mergers and acquisitions lawyers, notoriously, find M&A bankers annoying. The lawyers think they do all the work while the bankers take all the glory. But who do M&A bankers find annoying? Private equity executives, obviously.